BASIC INTRODUCTION OF INDIAN ECONOMY
India has seen a systematic transition from being a closed door economy to an open economy since the beginning of economic reforms in the country in 1991. These reforms have had a far-reaching impact and have helped India unleash its enormous growth potential. Today, the Indian economy is characterized by a liberalized foreign investment and trade policy, a significant role being played by the private sector and deregulation.
India has grown to become a trillion dollar economy with a largely self-sufficient agricultural sector, a diversified industrial base and a stable financial & service sector.
India now ranks as the tenth-largest economy in the world and third largest in terms of GDP on PPP basis.
India’s competitive position in the world
India’s economy has strong fundamentals and is host to several eminent global corporate giants that are leaders in their respective fields, according to Global Competitiveness report 2011-12, India ranks at 56 among 142 countries. The country ranks higher than many countries in various key parameters such as market size (3rd) and innovation (38th). It also has sound financial market, which ranks 21st in the world.
FDI in India:
According to UNCTAD’s World Investment Prospects Survey 2012–14, India is the third-most attractive destination for FDI (after China and the US) in the world. Indian markets have significant potential and offer prospects of high profitability and a favorable regulatory regime for investors.
Did you Know:
The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) are the premier stock exchanges of India. The BSE is the world’s largest stock exchange in terms of number of listed companies with more than 5000 companies. NSE is the world‘s third largest stock exchange in terms of number of transactions.
India’s Financial Market
India has a, robust, transport and stable financial market, which has gradually transformed from a highly controlled system to one that, is liberalized.
INTRODUCTION OF FOREX MARKET:
Foreign exchange market is a form of exchange for global decentralized trading of international currencies. Forex market functions as anchors of trading between different types of buyers and sellers around the world, around the clock.
The reason for vast and bursting Expansion of foreign exchange around the world is as below:
· Its huge trading volumes representing the large asset class in the world leading high liquidity.
· Its geographical dispersion.
· Its continuous operation: 24 hours a day, except weekends
· Variety of exchange factors affecting exchange rates.
· The use of leverage to Enhance profit/ loss margins.
· With respect to accounting size.
The Foreign Exchange market is finally beginning to acquire main stream attention. The Bank of International Settlement estimates that the average daily volume in the Forex market is
“4 trillion $ = Rs. 226660000000000”
Which make it by a far largest financial market place in the world!
There are 3 key elements of Forex Trading:
· LEVERAGE
· MARGIN
· EQUITY
Now the question is what is the role that is that India plays in such a great pool of fiancé market? How the foreign markets do effects the India forex market? , How do India effects the foreign Forex markets? , What are the results of fluctuations in the forex market in the Indian economy?
“Evolution of the forex derivatives market in India”:
This tremendous growth in global derivatives markets can be attributed to a number of factors. They reallocate risk among financial market participants, help to make financial markets more complete, and provide valuable information to investors about economic fundamentals. Derivatives also provide an important function of efficient price discovery and make unbundling of risk easier.
In India, the economic liberalization in the early nineties provided the economics rationale for the introduction of forex derivatives. Business houses started actively approaching foreign markets not only with their products but also as a source of capital and direct investments opportunities. With limited convertibility on the trade account being introduced in 1993, the environment became even more conducive for the introduction of the hedge products. Hence, the development in the Indian forex derivatives market should be seen along with the steps taken to gradually reform the Indian financial markets.
"Foreign Exchange Market in India"
The gradual liberalization of Indian Economy has resulted in substantial inflow of foreign currency capital into India. Simultaneously, dismantling of trade barriers has also facilitated the integration of domestic economy with the world economy. With globalization of trade and relatively free movement of financial assets, risk management, through derivative products has become a necessity in India also.
The participants in the foreign exchange market comprise;
(i) Corporate
(ii) Commercial banks
(iii) Exchange brokers
(iv) Central banks
India forex and derivative market have also developed significantly over the year .As per the BIS global survey the percentage share of the rupee in total turnover covering all currencies increased from 0.3 percent in 2004 to 0.7 percent in 2007 and further to 0.9% in 2010. The size of the Indian derivatives market is evident from the above data, though from global standard it is still in its nascent stage. Broadly, Reserve Bank is empowered to regulate the markets in interest rate derivatives, foreign currency derivatives and credit derivatives. Until the amendments to the RBI Act in 2006, there was some ambiguity in the legality of OTC derivatives which were cash settled. This has now been addressed through an amendment in the said Act in respect of derivatives which fall under the regulatory purview of RBI(with underlying as interest rate, foreign exchange rate, credit rating or credit index or price securities), provided one of the parties to the parties to the regulated under the RBI Act, Banking Regulation Act or Foreign Exchange Management Act (FEMA).
Presently the Indian Forex market is the 16th largest Forex market in the world in terms of daily turnover as per the BIS Triennial Survey report. As per this report the daily turnover of the Indian Forex market is around
“US$ 100 billion= Rs. 5683500000”
Including the OTC derivative segment. The growth of the Indian Forex market owes to the tremendous growth of the Indian economy in the last few years. Today India holds a significant position in the Global economic scenario and it is considered to be one of the emerging economies in the World. The steady growth of the Indian economy and diversification of the industrial sectors in India has contributed significantly to the rapid growth of the Indian Forex market the main centre of Foreign Exchange in India is Mumbai, the commercial capital of the country and other centers including the major cities like Kolkata, New Delhi, Chennai, Bengaluru and Cochin. All these Foreign Exchange Markets of India work collectively deploying latest technology. The Foreign Exchange Market in India is a flourishing ground of profit and initiatives taken time to time by the Indian Central Government also strengthen the foundation.
It is during the year 2008 that Indian Forex market has seen a great advancement that took the Indian Forex trading at par with the global Forex markets. It is the introduction of future derivative segment in Forex trading through the largest stock exchange in country – National Stock Exchange. This step not only increased the Indian Forex market volume too many folds also gave the individual and retail investor a chance to trade at the Forex market, that was till this time remained a forte of the banks and large corporate. Indian Forex market got yet another boost when the SEBI and Reserve Bank of India permitted the trade of derivative contract at the leading stock exchanges NSE and MCX for three new currency pairs. In its recent circulars Reserve Bank of India accepting the proposal of SEBI, permitted the trade of INRGBP (Indian Rupee and Great Britain Pound), INREUR (Indian Rupee and Euro) and INRYEN (Indian Rupee and Japanese Yen). This was in addition with the existing pair of currencies that is US$ and INR. From inclusion of these three currency pairs in the Indian Forex circuit the Indian Forex scene is expected to boost even further as these are some of the most widely traded currency pairs in the world.
“INSTRUMENTS OF FOREX MARKET “
· Foreign Exchange Forwards
A forward foreign exchange contract is a deal to exchange currencies - to buy or sell a particular currency - at an agreed date in the future, at a rate, i.e. a price, agreed now. This rate is called the forward rate.
A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be one day, a few days, months or years. Usually the date is decided by both parties. Then the forward contract is negotiated and agreed upon by both parties.
· Currency Futures
A currency future or foreign exchange future, is a futures contract to exchange one currency for another at a specified date in the future at a future exchange rate. A futures contract is similar to a forward contract, with some exceptions.
Futures contracts are traded on exchange markets, whereas forward contracts typically trade on over-the-counter markets (OTC). Also, futures contracts are settled daily on marked-to-market (M2M) basis, whereas forwards are settled only at expiration.
Most contracts have physical delivery, so for those held till the last trading day, actual payments are made in respective currencies. However, most contracts are closed out before that. Investors can close out the contract at any time prior to the contract's delivery date. Investors enter into currency futures contract for hedging and speculation purpose.
· Currency Swaps
Currency swaps are over-the-counter derivatives, and are closely related to interest rate swaps A foreign currency swap is an "exchange of borrowings", where the principal and interest payments in one currency are exchanged for principal and interest payments in another currency. Mostly corporates with long-term foreign liability enters into currency swaps to get cheaper debt and to hedge against exchange rate fluctuations.
The best example of swap transaction is paying fixed rupee interest and receiving floating foreign currency interest.
· Currency Options
Unlike futures or forwards, which confer obligations on both parties, an option contract confers a right on one party and an obligation on the other. The seller of the option grants the buyer of the option the right to purchase from, or sell to, the seller a designated instrument (currency) at specified price within a specified period of time. If the option buyer exercises that right, the option seller is obligated.
Investors can hedge against foreign currency risk by purchasing a currency option put or call. For example, assume that an investor believes that the USD/INR rate is going to increase from 45.00 to 46.00, implies that it will become more expensive for an Indian investor to buy U.S dollars.
In this case, the investor would buy a call option on USD/INR so that he or she could stand to gain from an increase in the exchange rate. The call option gives buyer of the option the right (but not the obligation) to buy currency on the expiration date.
Conclusion:
The derivatives market in India has been expanding rapidly and will continue to grow. While much of the activity is concentrated in foreign and a few private sector banks, increasingly public sector banks are also participating in this market as market makers and not just users. Their participation is dependent on development of skills adapting technology and developing sound risk management practices. While derivatives are very useful for hedging and risk transfer, and hence improve market efficiency, it is necessary to keep in view the risks of excessive leverage, lack of transparency particularly in complex products, difficulties in valuation, tail risk exposures, counterparty exposure and hidden systemic risk. Clearly there is need for greater transparency to capture the market, credit as well as liquidity risks in off-balance sheet positions and providing capital there for. From the corporate point of view, understanding the product and inherent risks over the life of the product is extremely important. Further development of the market will also hinge on adoption of international accounting standards and disclosure practices by all market participants, including corporate.
Increasing convertibility on the capital account would accelerate the process of integration of Indian financial markets with international markets. Some of the necessary preconditions to this as suggested by the Tara- pore committee report are already being met. Increasing convertibility does carry the risk of removing the insularity of the Indian markets to external shocks like the South East Asian crisis, but a proper management of the transition should speed up the growth of the financial markets and the economy. Introduction of derivative products tailored to specific corporate requirements would enable corporate to completely focus on its core businesses, de-risking the currency and interest rate risks while allowing it to gain despite any upheavals in the financial markets.
Increasing convertibility on the rupee and regulatory impetus for new products should see a host of innovative products and structures, tailored to business needs. The possibilities are many and include INR options, currency futures, exotic options, rupee forward rate agreements, both rupee and cross currency swaps, as well as structures composed of the above to address business needs as well as create real options.
THANK YOU
Deepak Surana
CAclubindia
